MNI POLICY: BOC's Hiking Pace Could Pause Longer Than Expected

By Yali N'Diaye

     OTTAWA (MNI) - The Bank of Canada has voiced its concern about falling oil

prices to the point it could downgrade its growth outlook in January, which

would set the stage for a longer pause than markets had initially expected.

     In fact, BOC Governor Stephen Poloz said Thursday in a speech to the CFA

Society Toronto that the policy rate, which was left unchanged at 1.75%

Wednesday, was "appropriate for the time being," a precision that was absent

from the policy statement.

     And while he repeated the need for rates to rise to a neutral range of

2.5%-3.5%, he added during a question and answer session that we won't really

know what the neutral rate is "until we are there."

     This time around, the central bank actually qualified the lower oil prices

as a "shock", the persistence of which will be an important factor in the

upcoming decisions. The next announcement will be on January 9, when the central

bank provides updated economic forecasts.

     Given the sharp drop in oil prices since the October Monetary Policy report

and oil production cuts, "activity in Canada's energy sector will likely be

materially weaker than expected," the policy statement said Wednesday.

     The central bank also acknowledged that the Canadian economy is entering

the fourth quarter with "less momentum," a tone reinforced by Poloz's comments

Thursday stressing the "disappointing" data.

     In fact, data released Thursday showed that the goods trade deficit widened

more than expected to C$1.2 billion in October, feeling the weight of the drop

in energy prices which drove down exports (-1.2%).

     That being said, if not for the impact of the energy sector, Thursday's

data were more encouraging than the headline number suggested. Non-energy

exports rose 1.6% in October as volumes rose 2.1%, and total export volumes

actually rose 1.2%.

     For the "decidedly data dependent" BOC, this is good news.

     So was the 1.6% increase in real imports of industrial machinery, equipment

and parts in October, a positive sign for investment activity in Canada, which

the BOC expects to boost productive capacity and ultimately exports, along with

strong foreign demand.

     That being said, the U.S.-China trade "war", a term Poloz is not hesitating

to use, also remains a threat to global growth and a key concern of the BOC,

although the central bank continues to stress it is a two-sided risk.

     Unfavorable developments on this front along with a persistent decline in

oil prices could leave the central bank on hold for longer than markets are

pricing in. Markets see a January rate hike as highly unlikely, with the

probability rising in March to reach 50% in April.

     In addition, the central bank expects inflation, currently at 2.4%

year-over-year, to ease more than expected on lower gasoline prices.

     Not to mention that the BOC's own measure of wage growth has not shown much

improvement, with the wage-common published Thursday rising 2.4% in the third

quarter, after 2.3% in the second quarter, still on a slowing trend since the 3%

reached in the fourth quarter 2017.

     In its October MPR, the central bank projected a 2.3% annualized GDP growth

in the fourth quarter, with CPI inflation at 2.3%, expected to fall back towards

2% by the end of March 2019.

     Its assumptions included the price per barrel of Brent at USD80, the West

Texas Intermediate at USD70, and the Western Canada Select at USD35, all higher

than they are today.

     Still, an upside surprise should not be dismissed as the central bank

monitors businesses' reaction to the new government tax incentives in response

to the U.S. tax cuts.

--MNI Ottawa Bureau; +1 613 869-0916; email: yali.ndiaye@marketnews.com

[TOPICS: M$C$$$]